Wednesday, September 9, 2009

The realities of commercial real estate loan market

The commercial real estate loan market is facing two nasty headwinds. The first one, which is more visible, is the maturity wall of commercial mortgages (many of which have been securitized via CMBS). Concentrated maturities with balloon type principal payments will make it that much more difficult to refinance these loans.

The second issue is the rise in payment delinquencies. The chart below shows the recent trend as well as a forecast by Real Estate Econometrics, projecting delinquencies to hit 5.4% in a couple of years.

It's not such a scary number relative to the residential mortgages delinquency rates, but it's devastating for the commercial property market. In fact the Beige Book survey that came out today pointed to commercial real estate market as a continuing drag of the economy:

Of course the rating agencies are playing catch-up, with a rapid fire downgrades of CMBS tranches. Here is the ratings transition matrix from Moody's just for the week.

And this is what Moody's had to say in their recent report (about lagging just a bit behind the market):

The review reflects adjustments we are making to two key inputs to our CMBS rating model -- stressed capitalization rates and property cash flows. We generally rated conduit and fusion transactions from 2006 through 2008 to an expected loss of about 2%, but we now expect that deals from these vintages will experience losses of approximately 5% on average.

These headwinds will have a significant drag on banks' performance, given that they hold $1.087 trillion (according to the Fed) of commercial real estate loans. On average it is about 15% of their loan portfolios, but for many regional banks who are concentrated in commercial real estate, this is even more of an issue.